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The Austrian School Theory to be Presented Before Congress: Gold vs. Bitcoin

Economist Jeffrey Herbener will be presenting a statement before the Subcommittee on Domestic Monetary Policy of the U.S. House of Representatives today in which he presents the Austrian theory of money and credit, and in which he makes the case for market management of the money supply.

I disagree with some of what Herbener is presenting, so let’s go over the part of his speech that bothers me.

The profit and loss test applies to all production in the market, including mining gold and minting coins. A gold mining company will produce when the revenues from the sale of its output exceed the costs of buying its inputs. The company moves labor, mining equipment, land, and other resources away from uses consumers find less valuable into gold mining, which consumers find more valuable. A minting company will produce when the revenues from the sale of its service in certifying gold exceed the costs of buying its inputs. The company moves labor, minting equipment, land, and other resources away from uses consumers find less valuable into minting coins, which consumers find more valuable.

Like the production of all other goods, production of money left to the market is regulated by profit and loss. Additional money is produced when demand for money increases or demand for other goods produced by the same resources decreases. If the demand for money increased, the value of gold coins would rise. Minting companies would increase production to capture the profit. As they increased the supply of certification service, its price would decline and as they increased their demands for resources to certify gold, resources prices would rise and the profit would dissipate. If demand for other goods declined, input prices would fall. Minting companies would increase production to capture the profit and, by doing so, eliminate profit from further production. In this way production of money in the market is socially optimal.2

While I fully agree with what Herbener is saying as it pertains to profit and loss governing the production of money (gold) in a free market, I disagree with his assertion that free market gold-as-money creation is the most “socially optimal” form of money and money creation.

Consider the following:

Imagine if all the gold in the world was used to represent the value of all the material goods in the world. The current global supply of gold in existence is roughly ten billion ounces. Those ten billion ounces would have to be divided up to represent trillions of “things”. The total dollar value of all assets in existence is in the quadrillions of dollars. Exactly how much each ounce of gold would be worth if the entire world were to use gold as its primary money is hard to say, but it is safe to say that it would be enormous.

Given that we know this to be true, how much of a shift in production to the mining of gold could be expected following a transition to the gold standard? I would wager that such a production shift would be epic in proportion. Gold mining stocks would shoot through the roof, and absolutely massive amounts of resources would be shifted into the production and mining of gold.

What social benefit does humanity derive from gold bricks sitting in bank vaults?

What social benefit does humanity derive by diverting tremendous amounts of resources into the mining of gold, just so that after the gold is mined it can sit in bank vaults, completely unappreciated for its aesthetic beauty. Those same resources could have been used to mine iron and make steel for the production of consumer goods.

The argument might be made that humanity needs money to trade with, so therefore the social benefit is derived from the existence of a money. However, I would argue that is not true. Humanity needs a money that cannot be arbitrarily inflated and is created through the free enterprise system, but this does NOT necessitate that the money be backed by anything in particular.

It is not any less feasible to fix the number of fiat dollars in circulation through a government decree than it is to fix the number of dollar units to an arbitrary weight of gold. Congress could simply dissolve the Fed, mandate that all banks move to a 100% reserve system, and that the Treasury stop the issuance of new debt. In fact, this would probably be less chaotic than a forced transition to a government mandated 100% reserve gold standard. The key here is that the units of account cannot be arbitrarily inflated, which is the only thing the Austrian theory cares about as far as bad economic effects are concerned. Austrian theory doesn’t particularly care what is chosen as a money, as long as whatever is chosen cannot be arbitrarily inflated.

Ron Paul argues for competition in money, whereby private mints would issue their own gold backed notes along side the existing fiat dollar framework. As an anarchist, I’m all in favor of competition in the supply of money. However, I want to make the case that gold-as-money is a poor choice in comparison to digital currencies, such as Bitcoin, because gold requires that massive real physical resources be diverted away from the production of consumer goods into the mining sector. Further, the supply of gold is always increasing, thereby undermining the value of the existing money.

Additionally, there is a limit to the feasible division of gold as a money. Once an arbitrary dollar amount is chosen to represent a specific weight of gold, should the economy experience tremendous growth over time, those units of account are not easily divisible beyond the smallest unit of account. Imagine if a penny was worth a car, and the penny was the smallest unit of account. Smaller and smaller fractions of gold would have to be created to deal with this problem over the long term. While I think the market would find someway to cope with this problem, the problem doesn’t need to exist in the first place if the money is infinitely divisible to begin with. Clearly gold is not infinitely divisible.

From this assessment, we can say that a “socially optimal” money should have the following characteristics, in addition to those already laid out by the Austrian School:

A socially optimal money should not precipitate the mass diversion of physical resources into the production of money.

A socially optimal money should be infinitely divisible to deal with deflation over the long term.

A socially optimal money is one in which the units of account are prevented from being inflated or co-opted by the state.

Gold does not meet any of those characteristics. As we have seen from our past history, the state can easily co-opt a gold money supply and inflate the units of account. The units of account are simply ledger entries or paper notes, either of which can be manipulated by unscrupulous bureaucrats. There is nothing that would mechanistically prevent this should the government decide to do it.

So let us contrast this with Bitcoin:

Bitcoin is infinitely divisible, so deflation is never an issue.

Bitcoin prevents the co-opting of the money supply through strong encryption and a decentralized ledger. The state could not take over the supply of Bitcoins no matter how badly it may want to do so.

Bitcoin “mining” does not divert tremendous physical resources into the production of money, and in fact, mining adds to the security and efficiency of the network itself.

Further, the maximum number of Bitcoins in existence is capped by its own algorithms. Any attempt to inflate the supply of Bitcoins would cause a fork in the block chain leading to a money that was incompatible with the existing money supply. Inflated coins would be easily identifiable and people would have the option to reject them by refusing to use a software client that accepted them.

In short, Bitcoin addresses all of gold’s shortcomings. Bitcoin is clearly a more “socially optimal” form of money than gold. Further, since Bitcoin is entirely digital, it can be transmitted across a wire transaction, thereby eliminating the need for expensive insurance and shipping costs. These costs needed to be accounted for under free banking, where banks would accept notes issued by other banks at a discount to cover the cost of transporting the gold between banks. With Bitcoin, this is not an issue. In fact, since Bitcoin is a global network, it would retain its full value between banks on differing continents!

While I appreciate the gold standard and Herbener’s address to Congress, I think it is time we stop advocating for Roman era money and start advocating for a 21st century upgrade.

Allow competing currencies in a free market. Let the market decide. Of course there’s no reason there has to be one main currency. We must remove the violence from the equation. Abolish the State.

Francisco d’Anconia

The proponents of Bitcoin do not understand what money is. Money is first and foremost a store of value. Given the choice in a free market of Fiat Money, Bitcoin, Gold, Silver, Copper, Nickel, Platinum or storage certificates for commodities such as sugar, automobile tires etc. In a free market Gold will be only one of the possible moneys out there. I wouldn’t be betting on digital currencies that does not at the very least entitle me to a claim on something of value!

http://www.libertariannews.org/ Michael Suede

They do entitle you to a claim on something of value. They entitle you to any good or service being offered by a vendor who accepts Bitcoin as a payment.

I’ve written extensively on this topic, so you can find out why you are wrong by simply looking at the Bitcoin category of posts on this blog.

The fact that a single Bitcoin is worth five fiat dollars demonstrates that Bitcoins have value because the market says they have value. Therefore, any assertion that Bitcoins don’t have value is proven to be false on its face.

Hank Rearden

They do entitle you to a claim on something of value. They entitle you
to any good or service being offered by a vendor who accepts Bitcoin as a
payment.

What if they stop accepting it? Bitcoin is evidence of the incredible confusion that exist between fiduciary media and real money.

http://www.libertariannews.org/ Michael Suede

What if other countries stop accepting the dollar?

What if people decided gold bricks didn’t have any value to them?

What if?

What we know is that Bitcoins have value right now, and that they will most likely continue to have value into the future because of the properties that they have which allow them to act as a money.

Peter Surda

Francisco, you omit the transaction costs. Trade opportunities are not costless and neither is the choice of medium of exchange. Money improves transaction costs over barter, similarly money substitutes improve transaction costs over money proper. And similarly, Bitcoin improves transaction costs over the current banking system.

See Menger in Principles of Economics, Chapter 4: http://mises.org/etexts/menger/four.asp

“But it is not easy to find an actual case in which an exchange operation can be performed without any economic sacrifices at all, even if they are confined only to the loss of time. Freight costs, loading charges, tolls, excise taxes, premiums for marine and other insurance, costs of correspondence, commissions and other sales costs, brokerage charges, weighages, packaging costs, storage charges, the entire cost of the commercial banking system, even the expenses of traders and all their employees, etc., are nothing but the various economic sacrifices which are required for the conduct of exchange operations and which absorb a portion of the economic gains resulting from the exploitation of existing exchange opportunities. Economic development tends to reduce these economic sacrifices, with the result that even between the most distant lands more and more economic exchanges become possible which previously could not have taken place.”

140 years ago, Menger understood what Bitcoin does.

Peter Surda

Money is the most liquid good. Whether you like it or not, Bitcoin is already highly liquid, and as long as it continues to have low transaction costs and there are no challengers, it will probably become more and more liquid. Bitcoin is already more liquid than many forms of fiat currencies.

Gold only has low transaction costs if there are no money substitutes. On a free market, it can only win if the financial system collapses completely, there are no banks anymore and the fiat currencies are abandoned in hyperinflation, in large parts of the world simultaneously. If merely the central bank stops printing money and the legal tender laws are lifted, that does not give gold sufficient advantage. If this happens only in one country, the currencies from will be the ones with lowest transaction costs. Recently in countries where this happened, such as Iraq or Somalia, the local currency was not replaced with gold. It was only supplemented by other currencies, but still remains in use. In Zimbabwe, their hyperinflated currency, was replaced on markets by currencies from other countries, not with gold.

Bitcoin however can easily compete on transaction costs with the digital and paper forms of money.

The Austrian story of the origin of money (AKA Mises’ Regression Theorem) only works as an explanation of how money develops from barter, and how fiat money develops from commodity money. It doesn’t work well if it has to explain why money A is replaced by money B on a free market. The choice of money is driven by transaction costs, not by “backing” or “intrinsic value” or any such nonpraxeological terms. Money evolves from barter because it lowers transaction costs. Money substitutes evolve because they lower transaction costs. Similarly, Bitcoin evolved to a medium of exchange because it lowers transaction costs. Maybe it will evolve into money, maybe it won’t. But it does not look very rosy for gold. While it might remain to be used as a store of value, I am skeptical about it being able to compete as a medium of exchange.

lollerskaterz

Well this is only theoretical masturbation. Nobody knows what will win out in a free market. The most important thing is that you both agree on method of selecting the best one.

Dave54321

Suede is missing the point by a country mile. Herbener is not suggesting one should attribute an arbitrary value to gold. Take Suede’s thought experiment: “Imagine if all the gold in the world was used to represent the value of all the material goods in the world.” Why imagine something as stupid as that? Again, no one is suggesting that gold (or anything else, for that matter) should be used to “represent” value. What would be the point in that? We have that right now; it’s called fiat money. On the contrary, as any sane person knows, gold intrinsically has its own value, as does silver, platinum, oil, and any other number of goods. Gold happens to be one of the more stable goods when it comes to holding value.